Budget Constraints and Psychology

The following situation has occurred to almost everybody: You are on holiday and want to get money from an ATM cashier; the machine swallows your credit or debit card. This is worse if it happens during night when all banks are closed and even worse if it happens in a foreign country. Last year, at the LACEA-LAMES meeting held in Santiago of Chile, Sendil Mullainathan[1] used this example to explain how budget constraints could affect consumption decisions, which is not surprising, but most important how they could affect the behavior of people regarding their labor supply.

Consumption theory states that people will tend to smooth consumption over their life cycle. Therefore it is of no surprise that people with severe liquidity or budget constraint would be more worried about smoothing consumption. Hence, they will pay much attention to prices and will buy only the strictly needed. This is precisely the way poor people think when making their consumption decisions. In the opposite side, rich people think first on what they need and then they look at the prices and ussually they end up buying more than what they really need. Think about the sequence of thinking and on the “pressures” that poor and rich people are subject. Certainly poor people are subject to more “pressures” than rich people.

There is nothing new in terms of economic theory; it is just the application of the so-called “budget constraints”. However, there is a psychological extension which I think it is worth mentioning and that could well apply to the Bolivian case, in particular if we want to understand a little bit more about labor supply. The “pressures” that I mentioned in the previous paragraph and in the consumption decisions’ example, could be generalized to the way poor people live and think. Think again about the easy for rich people is to make consumption decisions, they don´t have to worry about many things at the same time. In contrast, poor people have to worry about many things at the same time, and have to take many decisions subject to also several constraints.

By employing experimental economics, Sendhil Mullainathan and other researchers have found that when people have many things to do and to think at the same time, their efficiency decreases. These experiments consisted in subjecting students from Princeton University to a range of pressures and concerns. The results showed that despite being high skilled students, once they were subject to different type of pressures at the same time, their efficiency in performing some basic tasks started to decrease.

In Bolivia it is typical that low skilled workers like construction workers, plumbers and others  are characterized for not finishing their work in the time they say the will finish. Therefore many people argue that “Bolivians are lazy for cultural reasons”. I think that is totally wrong, we have to consider also, they have many things to think about, and to do at the same time. Hence, this psychological way of thinking about budget constraints could help us to understand why labor is not supplied efficiently in Bolivia. And going a little bit further, maybe it could help us also understand why people drink so much. Nice ideas for future research.

Do you think budget constraints can affect people psychologically? Share your thoughts below.

Carlos Gustavo Machicado has worked as a macro-sector analyst for the Unit of Economic Policy Analysis (UDAPE). His areas of interest are Macroeconomics, Economic Growth, Productivity, General Equilibrium Models and Economic Policy.

[1] Professor of Economics at Harvard University conducts research on development economics, behavioral economics and corporate finance. 

* Investigador Senior del Instituto de Estudios Avanzados en Desarrollo (INESAD). El autor recibirá con mucho gusto cualquier comentario al siguiente correo electrónico: cmachicado@inesad.edu.bo .